I find it helpful to step inside sector performance when assessing the health or potential weakness ahead for the broader Stock Market.

Let’s take a look at recent signals before and after the sharp May stock sell-off along with what signals appear currently.

First, let’s compare the Consumer Discretionary (Retail) Sector with the Consumer Staples Sector, both of which give us clues as to “Risk-On” or “Risk-Off” trends in money flow.

Here’s the Daily Chart of XLY – Consumer Discretionary Sector:

We’re not looking to do complex technical analysis when we’re studying this type of Sector comparison.

The goal is to use simple trendlines and descriptions to arrive at a conclusion of strength or weakness and the interplay between these two Sectors.

Despite a rally to new highs in late April, the XLY ETF continued its sideways motion and eventually broke sharply lower – with stocks – in mid-May on stronger volume to the downside.

Currently, the fund is retracing up into the confluence resistance near the $44.00 per share level – a level which we’ll be watching closely.

One can view the XLY Chart to assess strength in Retail or Consumer Discretionary stocks as part of a “Risk-On” or Bullish market environment.

To view “Risk-off” or a cautious/bearish market environment, we can look for relative strength in the Consumer Staples Sector using the XLP Fund:

In general, the Consumer Staples sector – and stocks within it such as Proctor and Gamble (PG) and Kraft Foods (KFT) – is less volatile than the Retail Sector fund which includes companies such as Amazon (AMZ) and Starbucks (SBUX).

Looking at the chart, we see a similar consolidation pattern from March to present, but we do NOT see the distinctive spike to new highs in April nor the sharp decline/breakdown in May as we saw in XLY.

We’re also not seeing big differences in volume as we saw with a steady surge of selling volume in XLY.

It’s difficult to see clear differences in price performance by looking at the charts individually, so to get a better picture, it’s often best to overlay price performance of these funds, usually along with the S&P 500 index.

This is what the color-coded chart below reveals:

Let’s remember a basic principle when looking at the chart above:

Retail (XLY) tends to outperform during periods of Market Strength while Staples (XLP) tends to outperform during periods of Market Weakness.

During the early 2012 stock rally, we saw Retail/Discretionary – the Green Line – steadily rising ABOVE the Red Line or the Staples Sector.

This was true until early April when a surge of buying pushed the Staples Sector above the Green/Retail Line – that was an early sign of potential weakness.

From April, during the sideways move in the Stock Market (and these funds), the Staples Sector outperformed the Retail Sector with the exception of the tiny blip at the start of May.

Strength in Staples is often a sign of potential future market weakness, as was the case here.